Editor's Note (June 24, 13:15 UTC): After publication of this article, Deribit, the exchange upon which the options trade in question was made, told CoinDesk that the party who took the loss on the $2,560 put option trade was a market maker (who is typically completely hedged) and the buyer made over $3 million. Per Deribit's CCO, the buyer opened the position during the bull run, leading to a sharp rise in open interest and the Wednesday's decline in open interest was the result of the client taking profit when the put traded at a much higher level as the ETH market dropped. Deribit didn't respond for requests for substantiation of the profit-making trade.
A trader may have just learned the hard way that it’s pretty easy to lose $3 million in the volatile world of the crypto options market, according to options analytics platform Genesis Volatility.
It appears the ether put options seller took a large bet against a sharp drop in the cryptocurrency and ended up booking a massive loss on Tuesday as the token powering Ethereum's blockchain tanked to a three-month low of $1,700, Genesis said.
“The market moved just enough to force the trader to take a loss by buying back 5,000 contracts of the December expiry $2,560 put option sold earlier this quarter," Gregoire Magadini, Genesis Volatility CEO, told CoinDesk in a Telegram chat. "The trade looks to have yielded a loss of over $3 million."
A put option gives owners the right to sell the underlying asset (in this case, ether) at a set price on a certain date. Holders of the option make money when the price falls below that “strike” price and are implicitly short the asset. Conversely, sellers of the option benefit only when the asset trades above the strike and are implicitly long.
The ether options trader likely sold the $2,560 puts during the bull run, expecting a continued rally to last at least until the end of the year and thus a steady drop in the option's price.
Ether peaked above $4,000 on May 12, however, and fell to $1,700 on Tuesday, boosting the value of the $2,560 put and bringing sharp losses to the seller. The trade was executed and squared off on Deribit, the world's largest crypto options exchange, where one ether option contract represents 1 ETH.
The possible loss underscores that selling options, be it a put or a call, is a strategy better suited to institutions with ample capital supply and high-risk tolerance.
Data from the exchange shows the trade as it occured. The number of open positions in the $2,560 put expiring on Dec. 31 saw a 10-fold increase to more than 12,000 contracts in the four weeks ended May 12 — when ether prices doubled to over $4,000 — and fell by 5,000 contracts on Tuesday.
"Majority of that open interest was opened on the short side," Magadini said.
Calculating the loss
The short position that was squared off on Tuesday likely saw around a $3 million loss. How so?
Due to data limitations, the exact price at which the trader sold 5,000 contracts of the $2,560 put is not available. Magadini, however, recommended using the put option's average price of $447 observed between mid-April and mid-May as the entry price for a profit-and-loss calculation. It's probable that the trader kept selling small quantities as ether moved higher during those four weeks.
So, the seller likely received $2.235 million in premium by selling 5,000 contracts at an average price of $447. Those contracts, however, were repurchased on Tuesday at a much higher per contract price of $1,080, amounting to a total outlay of $5.44 million.
Essentially, the trader sold puts at $2.235 million a few weeks ago and then repurchased them for $5.44 million on Tuesday, netting a loss of over $3 million. That amount may seem heavy, but the trader likely did so out of fear the position would bleed further losses.
The puts’ value began rising as ether fell below $2,500 last week and surged to $1,080 during Tuesday's early U.S. hours, when the cryptocurrency itself dipped to $1,800.
The short position was squared off when ether was near the lowest point of the day.
Further, it was closed on Deribit and not through an over-the-counter desk like Paradigm, a preferred venue for institutions. Magadini, therefore, believes it was a classic case of a retail investor getting burned by selling options.
Lastly, some informed readers might wonder if the short position was a part of the bull put spread or other complex strategies. A bull put spread consists of selling a higher strike put and buying a lower strike put with the same expiry and profits from a rising market or consolidation. The advantage here is that the long leg of the strategy caps losses during a sell-off and is a much safer way of collecting extra yield during bull runs than selling a naked put.
But there is no evidence that the sell position in the $2,560 put was accompanied by a buy position in the put options at lower strikes. Had that been the case, the trader would have squared off the buy leg along with the short leg on Tuesday, causing a big drop in open interest in puts below $2,560. That doesn't seem to be the case here.
"We haven't seen other options closed along with the December expiry $2,560 puts," Magadini noted.
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